MicroDell: It's All About the Margins

NEW YORK (TheStreet) -- Word that Microsoft (MSFT) is interested in financing a private buyout of Dell (DELL) has the news world all a-twitter.

The New York Times reports that Silver Lake Partners, the private equity firm working with Dell, reached out to Microsoft, and there may be nothing more to this than an investment opportunity.

Take a piece of equity in the turnaround, let the private equity boys work their magic, and take your profit on the back end after the costs are wrung out and the public is hyped to buy it back.

But there has to be more to this, says Bloomberg. This will "strain relationships" with other PC manufacturers, not just Hewlett-Packard ( HPQ) but Lenovo ( LNVGY) and others. Why risk your ecosystem?

Because the ecosystem world is dead, or at least dying.

In the new device world of Apple ( AAPL) and Android, you must control your inputs in order to control your product roadmap. Google ( GOOG) took a financial hit when it bought Motorola, but it now has a stake in the hardware, it knows what things cost and what's possible.

The same sort of thing happened after Microsoft signed a partnership agreement with Nokia ( NOK) in 2011 -- the Windows Phone business isn't exploding, but Microsoft now has a finer-grained understanding of what's needed.

So this deal, if it's done, seems to be all about the tablet market. That's where Microsoft is especially weak, and where it has to do better if it's to regain momentum. The Surface line is seen as over-priced, and the Windows RT operating system running on ARM Holdings ( ARMH)-based chips looks like a total disaster. Something has to be done.

There are analysts like George Kesarios at Seeking Alpha, calling for Microsoft to buy all of Dell, but that would get government anti-trust lawyers involved. As the Nokia deal shows, it's just not necessary.

Since Nokia signed that deal it has lost half its value, and it recently suspended its dividend. Microsoft doesn't need that risk on its books. But Nokia did sell 4.4 million Windows 8 phones in the last quarter, The Wall Street Journal reports, and its downward momentum seems halted for now.

Microsoft has other ways to win with a Dell investment. Dell server racks can help it expand its Azure cloud operations at low cost. Dell's own cloud, which runs on OpenStack, would give it insight into other parts of the cloud market.

If Silver Lake can get a deal done for $25 billion, a roughly 10% premium to Dell's current market cap, Microsoft could take a little less than 20% of that for cash on hand, knowing it has another $60 billion in short-term investments on its books. That would keep Dell's results off Microsoft's books -- Google margins are still being driven down by its Motorola investment.

Now, suddenly, Microsoft has a platform for its tablet work that's better than what Nokia offers it in phones. It has all the connections and financial leverage it could need in China to get access to the best parts at the best prices, and deliver something that's truly competitive with Android and even Apple.

You know, the company Microsoft saved with $150 million back in 1997, as CNET reported at the time. That worked out pretty well.

Through Dell, in other words, Microsoft can deliver a Surface product at a lower price with better margins than before, and gain all the same advantages in cloud hardware, an area where costs are going to be an issue, as the current price war with Amazon.com ( AMZN) and Google grinds on.

No, this is not a deal being done from strength. It's a deal being done from weakness. There is risk in this deal. But there is more risk in doing nothing at this point. Letting the PC business slowly drift away while there's nothing to take its place is not an option.

At the time of publication the author had positions in ARMH, AAPL, MSFT and GOOG.